CLIMBING THE WALL OF WORRY

CLIMBING THE WALL OF WORRY

13/09/12 @ 07:17 GMT by Michael Derks, Chief Strategist

Yet another day of decent gains for the single currency as it continued to mount the wall of worry. Yesterday, a further major hurdle was overcome with the favourable decision of the German Constitutional Court, the euro climbing further through the 1.29 level. The judges in Karlsruhe ratified the ESM with only light conditionality, while in the Dutch elections the centrist parties are likely to hold sway once the final results are announced. For the dollar, it was another day of losses, with cable now trading above 1.61 and the Aussie briefly breaking 1.05. Peripheral sovereign and corporate bond markets performed well and the gold price was well-bid. Next up is the Fed and given how far expectations have run this week it would be no surprise at all if we witnessed some profit-taking on dollar short positions just before and possibly after the announcement.

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Commentary

Britain’s labour mystery. The British labour market mystery continued to deepen last month with the number of claimants for unemployment benefits declining by another 15K to 1.57m. Even more extraordinary were the latest employment figures – in the three months ended July, the number of people in work jumped by 236K, after a 183K rise in the previous three months. As such, jobs growth over the six months to July was a remarkable 1.4%, at a time when the economy remains in the vice of a debilitating recession. Understandably, economists are having a tough time explaining these two apparently inconsistent outcomes. Part of the explanation is that employers might have been too aggressive last year in terms of reducing the size of their workforce; in the second half of 2011, employment fell by around 80K. Another rationale for the disparity is that a higher proportion of those obtaining work are doing so on a part-time basis. Unable to find full-time work, they are being forced to accept whatever work they can. Also observable this year has been an increased preparedness to actively search for work, as shown by rising labour force participation. As a result of the latter, the unemployment rate remains stuck above 8.0%. Policy officials on the MPC will continue to reflect on why the labour market is so robust at a time when the overall economy is retreating. Is growth being understated and jobs growth overstated? Will the labour market return to ‘normal’ now that the Olympics and Paralympics are finished? Whatever the explanations, the labour market is one of the very few bright lights for the UK economy at the present time.

Aussie bears get smoked. A week can be a long and painful time for those who trade the Aussie, and so it has proved for those of a bearish persuasion over the past seven days. Last Wednesday, the AUD was below 1.02 and parity seemingly loomed. However, with the dollar retreating fast as conviction grew that the Fed will press ahead with QE3 today, and with the ECB committing to unlimited bond purchases, risk appetite has swooned and high-beta currencies have prospered. China is also now openly discussing additional fiscal and monetary stimulus, as it should given the deterioration in their economy. How much further this relatively rapid bounce can go remains to be seen. If the Fed’s commitment to more QE today is less than definitive (for instance, it may opt to hold back on revealing the size and/or timing), then we might see the dollar reverse some of its recent losses. At the same time, the euro bears have been forced into hibernation by the price action of recent weeks, and likewise Aussie bears have been smoked by this latest spike. Notwithstanding the euro’s impressive price action in recent weeks, all is not rosy in Europe’s garden, with recent developments in both Spain and Greece deeply troubling. Down under, the economy remains vulnerable to both falling commodity prices and the slowdown in China, not to mention concerns regarding the over-valuation of residential property. As such, with respect to the Aussie, in the short term it may be more profitable to expect the currency to trade within a range, bounded by 1.06 on the topside and parity below.

Tokyo’s renewed discomfort. The appreciation in the Japanese yen over recent days has attracted the ire of policy-makers in Tokyo, although frankly these are wasted words. Finance Minister Azumi described Tuesday’s yen moves as “speculative”, and reiterated that bold action would definitely be forthcoming if necessary. Japan has an explicit and extensive currency intervention war-chest available to stand up to capital inflow should it be deemed a desirable course of action. That said, Japan should relax, as the recent depreciation in USD/JPY is a dollar weakness story rather than anything specifically connected to the yen. Indeed, for the month-to-date, the Japanese currency has fallen by nearly 2% against the euro and 0.7% against both the Aussie and the pound. Also, in trade-weighted index terms, the yen is only slightly above the 12mth average. The MoF surely must appreciate that there is little that can be done to arrest the appreciation while the fundamental value of the greenback is being re-aligned. If it was seriously contemplating intervention somewhere near the current level, then this would be foolish and probably unsuccessful.